What's Killing the U.S. Dollar and Its Impact on Income Investors and Markets

While recent news on the US economy, especially the non-farms payroll data, as been positive (OK, more like less negative than expected), in the past weeks, a number of powerful long term market trends have continued in currency and commodities markets and should continue over the coming months, albeit with the usual short term counter moves.

In sum, these include:

• The weakening dollar against all major currencies.
• The ensuing up trend in commodity prices (commodities are priced in USD) and their related currencies, the CAD and AUD against other major currencies.

However, we remain skeptical that the multi-month rally in equity markets will endure. Thus we do not recommend new long positions in them, and await shorting opportunities.

Here are the details:

What's Killing the Dollar?

The biggest single story is the deterioration of the long term fundamentals of the USD. Why? In short, President Obama has no choice but to continue to expand the money supply at rates that will badly damage its value.

A. Why Washington Must Continue to Print Dollars

Washington has no real choice but to continue inflating money supply at unprecedented rates, because it is faced with a virtually unprecedented situation.

1. The Immediate Threat: Lack of Liquidity Causing Financial Collapse

President Obama is like an emergency room doctor dealing with a patient who has just been shot in the heart and will die in minutes if the heart can't be repaired and the blood circulation restored. The bullet was the subprime crisis and ensuing collapse of the housing and credit markets.

Thus he must first keep the heart going and stop the bleeding. The heart here is the financial system, particularly the largest institutions like Citibank (C), Bank of America (BAC), and those that insure their huge debt portfolios. It these bleed out liquidity, they will stop beating out available cash to depositors and credit to businesses, the lifeblood of the financial system and upon which it depends. The heart, the banks cannot stop beating out blood, cash and credit, or the patient, the US economy, dies on the table.

So the printing of new dollars and expansion of money supply must continue.

2. The Underlying Disease – Excess Debt + Money Supply = Weakening Dollar

Unfortunately, the patient is already suffering from a potentially fatal cancer of a weakening USD caused by massive debt, government bailouts of the financial sector, and expansion of money supply to pay these. There is no historical precedent for a country inflating its way to prosperity. While many argue massive spending saved the US from the depression, others would argue that the real cure was that WWII left about half the world's production destroyed and the US became the producer of about half the world's goods and services. But I digress.

To cure the immediate threat to the patient/economy, the doctor must continue to create new money/blood, which worsens the long term cancer of a weakening USD and inflation. If left unchecked, this cancer of a weakening USD will ultimately force up interest rates and may choke off the liquidity/blood supply from the heart/financial system.

Oh yes, major organ failure is continuing, with the bankruptcies of GM (GMGMQ.PK) and Chrysler, plus a slow but steady rise in bank failures. These in turn threaten another spike in unemployment, ensuing residential foreclosures and reduced consumer spending. These in turn could cause further declines in:

• Overall business activity
• Values of banks’ commercial real estate and mortgage portfolios with further oversupply
• Banking income and balance sheet health and more commercial real estate foreclosures
• Local tax revenues and ensuing credit worthiness of local governments etc.

"Doctor Obama to ICU, STAT."

What's that loud beeping sound? Better fix the heart quickly!

The Results of a Weakening USD for Commodity Markets

Because they are priced in USD, commodities and their related currencies (AUD and CAD) are expected to continue their long term uptrend as the dollar weakens, even if relative supply and demand remains unchanged. Additional long term reasons for rising commodity prices include:

• Upward pressure on oil prices due to both the relatively inelastic long term demand, and the continued solid growth of the Chinese economy.
• As the USD's position as currency of last resort fades, demand for gold (and silver) increases because they're seen as safe stores of value.
• As China, other export economies, and other large holders of the USD lose confidence in the USD (public statements to the contrary aside), they buy commodities both to hedge (there is no obvious liquid substitute for the USD at this time) their wealth and to ensure a relatively cheap supply to support their production at lower prices.

Equity Indices

The multi-month trend in equities, however, appears far less durable.

Since March, major indices continue to rally despite minimal signs of true turnaround in the underlying fundamentals of their economies. Consider:

• Most of the positive news on which markets have risen consists of slowing contraction, not growth.
• The apparent return to profitability by the financial sector was the cause of the stock markets' latest rally. There is significant evidence that the prior quarter's results were not sustainable. In addition to evidence of outright manipulation of those results (beyond the scope of this article) consider:
• Recent problems in commercial mortgages like the failure of GGP, one of the leading mall operators.
• Coming interest rate resets in the next 2-3 years and resulting possible increases in foreclosures and erosion of bank residential mortgage portfolios.
• the continued deep problems in industries that employ the largest numbers, like construction and autos, and the effects of their decline on the values of the financial sector's residential and commercial lending portfolios.

The continued rally in the US stock markets has been more of a low volume, low credibility rise based more on short-covering by quant funds than a believable rally supported by real fundamental and technical evidence.

Could the rally continue for a while yet? Sure, especially with Washington and Wall Street cooperating so, ahem, intimately. But how many are willing to take new long positions after a 30% rise in stock prices without real improvement in underlying fundamentals beyond merely a slowing contraction?

Ramifications for High Dividend Stock Investors

In sum, we appear to be at the upper end of a trading range, with the overall trend continuing down. Continue to invest only with funds allocated for longer term investment that you don’t need for the next six to eighteen months at least. What you buy now may well go lower.

Consider a Partial Hedge with Selected Ultrashort ETFs

Thus, in addition to collecting your high yields, those seeking a more active hedge may wish to consider taking measured positions some of the Ultrashort Proshares ETFs as a partial hedge. For the unfamiliar, these are ETFs that move at twice the inverse of a selected sector of stocks. Thus for example if the S&P 500 index falls 1%, then SDS, its Ultrashort ETF, will rise by 2% (and vice versa).

The time is ripe to consider some of these. While by nature these are volatile, you want to buy these only as a partial hedge at strong support when the market has just stopped feeling very optimistic, as a rally begins to show signs of fading.

This looks like the time. Consider taking partial positions in the following.

• UltraShort S & P 500 Proshares (SDS) – Buy under $60, Strong Buy under $55
• UltraShort Financials ProShares (SKF) -- Buy Under $50; Strong Buy below $40
• UltraShort QQQ ProShares (QID) – Buy Under $40, Strong Buy under $35
• UltraShort Real Estate ProShares (SRS) – Buy Under $30, Strong Buy under $20
• UltraShort Russell2000 ProShares (TWM) – Buy Under $50, Strong Buy under $40

If you look at a chart for these, you’ll note my buys are very conservatively low. There is a lot of cash on the sidelines now, earning virtually nothing. Big players and insiders continue buying stocks we’ve been mentioning, because they’re clearly cheap and excellent long term values. As the past few months have shown, any glimmer of positive news brings buyers as everyone is waiting for the sign to jump in. Lots of cash on the sidelines will provide lots of fuel in the tanks for a rally.

If that happens, these ultrashorts can plummet fast, so you only want to buy them at strong support, so that if these levels don’t hold up you’ll know quickly and can get out before taking a big loss. Thus place sell stops no more than 10% below the Strong Buy levels to protect your capital. There are other Ultrashorts for other sectors, like the Ultrashort Oil and Gas (DUG) for shorting oil and gas. This one has been popular, but betting against energy and other commodities is dangerous and strictly for short term traders with expertise in these, so avoid this one.

Continue to Take Partial Positions at Our Recommended Strong Support Levels

Beyond the Ultrashort ETFs if you can earn reliable dividends from 8-12 percent or more while you wait for recovery, ongoing investment makes sense. You just need to find the best bargain priced quality high yield stocks, and collect your income while waiting for the market to improve and offer additional options. As noted above, with a confirmed downtrend and good evidence for a further 20% overall drop, refer to our past recommended buy levels, which are at strong support levels.

Since prices are up and thus yields are down, many of our stocks are above recommended buy points. Do not chase them, though taking partial positions above these prices is acceptable for those with lots of cash lying fallow. This is particularly so with the energy producers.

Remember our key criteria for new stock purchases: In sum, we’re seeking stocks of strong companies that mostly earn and distribute a high dividend in a non-USD currency and have a dominant position in a market for an essential product or service. Ideally, the stock’s fortunes should rise with those of commodities and other hard assets that remain in demand, like residential real estate, power generation and distribution, etc.

That’s my focus here.

Use Sell Stops?

While our emphasis is buy and hold as long as the distribution is safe and fundamentals hold steady, some may want to hedge their bets, especially if they may need the cash within the next year or so. Those in that position should consider using sell stops around 15% below the Strong Buy price as partial principal protection, though you risk getting knocked out of your positions, only to see them come back soon and possibly rise higher while you miss the dividend. It’s a judgment call, though not a bad one for at least some of your holdings given the current pessimism (which of course can change, fast).

Again, our focus is on getting high yields from healthy businesses whose price will recover while we earn outsized returns, and we don’t try to time the market too much.

Conclusion, Disclosure & More Info

Bear market rallies are a normal part of bear markets, and they can indeed last for months. While they are driven by positive news, what distinguishes them from market bottoms is the lack of evidence of long term improvement in underlying fundamentals. Slowing contraction is good, but it doesn’t necessarily mean a bottoming.

Thus we continue to warn, “beware the bear.”

Opinions presented are strictly those of the author and of those disseminating these articles or otherwise associated with the author.

Coming articles will examine individual categories and stocks in greater detail.

Disclosure: I have positions in most of the above mentioned investments.

Comments

[optionsgirl:]

The opportunity to buy calls with long expiration dates on inverse etf's , or puts on the long index etf's is the way to buy some cheap protection. It may be necessary to do it several times.

On Jun 07 11:40 AM yellowhoard wrote:

> It takes some cajones grande to short this market with the Fed and
> Treasury actively gunning the markets up as they deem neccesary.

Jun 07 01:37 PM

[whidbey:]

Good review and I agree with your analysis of the drivers in the market. But timing is everything in shorting. The rise in interest rates will eventually drive equities down, as will a lack of earnings so I would not accept your equity recommendations and I would long the short etfs only when the trend is down. Instead today and longer, I would buy growth emerging markets with stable currencies, look at the ideas below.

You fail to mention PM, commodities and energy, all of which have excellent prospects regardless of how rapidly the Fed monetizes debt or where yields go, or how badly the dollar is trashed. The QE program is not dead and it too will ruin the dollar when it is clear that GM/the banks are having a long, costly funerals. Go off shore for investments, and buy agriculture, industrial metals, water, and energy. Check DVB, UDN, FXC, FXA, and short US markets only with the trend clearly down (like in August maybe)

Jun 07 03:56 PM

[Donald Ingram:]

Good in depth analysis of present conditions.
Agree that the present rally is a six month bear, after which the trap door opens sometime this Autumn, zooming right on down past the March lows. The bottom bounce will generate a "last gasp" rally, post Christmas into early spring before the markets totally capitulate at Dow 1450.
The level of suffering coming to the United States will be shocking.

Jun 07 06:23 PM

[kenley kyle:]

I’ve noticed a significant increase in the foreclosure lists locally within the last few weeks. Yes the organ failure continues and yes I think consumer spending gets much worse before the end. As the Wildcats might put it bear down.

Jun 08 12:45 AM

[beijingpaddy:]

Concerning the patient in the ER, the underlying disease is not cancer but high cholesterol and clogged arteries from living too well for too long. A disease of the rich. A diet and change in lifestyle is in order. Hard for the patient to accept, MDs unwilling to prescribe.

The basis of wealth is not finance but production. Wealth finance is created largely from production and not the other way around. Production has moved east. America and Europe are hollowing out. Both (include here also Japan, and the Asian Dragons) are all trying to move into high end, high tech, high margin, products. Too many competitors. Not enough to go around. Result: squeeze the home workers (wages, pensions, etc.), move more production east, and a take the money and run, you only live once kind of mentality among the top tiers (excessive bonuses etc.). To make things worse, the current occupant in the White House is a creation of the mass market media (no wonder they are fading fast, we already have one Disney and that's enough fantasy). So the media will not begin a national discussion (loss of face) on what changes and sacrifices have to be made to leave some money for the surviving family.

This scenario has no long term solution. Patient will surely have to endure a slow and painful death.

If you have any money left, invest in China. Although China has problems of its own to solve, at least these are doable (not systemic), and there is the national and political will to make whatever sacrifices are needed in order for China to develop and prosper. In fact if every American and even the US government invested in China while valuations are still reasonable, most of its financial woes could be solved in a few short years. What would happen to the USD then?

Sad ending. Must be a better solution.

Jun 08 01:02 AM

[doubleshortetf:]

Great insights. Been scooping up QID, SDS, TWM and SKF in last few weeks and especially last 5 days on QID/SDS/TWM.

Agree on your recommended prices to enter QID/SDS/TWM too.

As for those saying it's too risky to short this pig uh meant to say bear market rally long in tooth and low volume build on hope or less bad - you make $ to be ahead of the turning point.

Jun 08 10:50 AM

[Jimbo:]

an excellent but scary and depressing summary.

Jun 08 11:29 AM

[David Van K...:]

Good article.

The underlying disease--the "cancer"--is massive debt, at every level of the financial system: from individuals all the way up to "too big to fail" banks and their insurers. The debt, of course, is the result of millions of bad decisions--about mortgage offers and acceptances, about real estate prices that would go up continually, about using homes as ATMs and failing to build equity by repeatedly taking cash out, about the abandonment of all kinds of traditional and time-proven risk controls, and so on.

My appreciation expressed, I do question a couple of your statements.

1. "The apparent return to profitability by the financial sector was the cause of the stock markets' latest rally." If you are referring to the entire rally that began March 10 and is now almost 3 months old, that's highly unlikely. Not many investors fail to see that the Q1 bank profitability results are probably not sustainable. Beyond a bump lasting a day or a week, those profitability reports are old news, and they did certainly not fuel the entire rally.

2. "Could the rally continue for a while yet? Sure..." seems to contradict "...we appear to be at the upper end of a trading range." If the rally continues for a couple more months, then we are not at the upper end of the trading range. The market went up 9% in March, 9% in April, 5% in May, and 2% in the first week of June. At that rate, if it goes up for another couple of months, it's still 10% off its highs. Why would you bet against it right now, especially with accelerated ultra-short ETFs? I think you ought to reconcile those statements: Either you believe that the rally is over, or that it's not. The two beliefs lead to very different investment tactics.

3. "...with a confirmed downtrend and good evidence for a further 20% overall drop..." Where did this come from? You've presented no evidence for it. It's a hunch or a belief, right, not the result of a fact-based calculation?

Here's the best statement in the whole article, a great thumbnail sketch of where we may be right now: "Bear market rallies are a normal part of bear markets, and they can indeed last for months. While they are driven by positive news, what distinguishes them from market bottoms is the lack of evidence of long term improvement in underlying fundamentals. Slowing contraction is good, but it doesn’t necessarily mean a bottoming."

That is true. However, slowing contraction is a necessary pre-condition for improvement of underlying fundamentals. The economy does not turn on a dime. It cycles. Clearly, the current rally has been fueled by short-term traders along with investors who think that the slowing is a precursor to a turnaround and then improving earnings and real wealth creation. That's the way all bear markets have ended, and most of them did it by starting back up in the middle of a recession, as this one is doing right now. Generally, the market moves before the economy.

Jun 08 11:39 AM

[dsrtwriter:]

Unfortunately Barack Obama's heros fall more along the line of Fidel and Hugo Chavez than our Founding Fathers, whom he regards as exploitative slaveholders.

So we will continue to see massive spending through debt as he ramps up the typical socialist smorgasbord of benefits, while continuing to fuel his internet based grass roots pressure groups to intimidate even moderate Democrats to fall in line with his agenda.

Like so many of the Sixties drugs, the "high" of eco friendly projects and laws all done in a totally contradictory world of free trade with China and other nations who will continue to use coal, pollute, etc., will finally end, with a crash.

I frankly don't think that Obama has learned the lessons of Eastern Europe.I'm sure the Czech President and others would be happy to advise him on this folly, but Barack only listens to himself and his spouse. This will not end well.

Jun 08 12:54 PM

[searcher:]

"Don't fight the Fed" Go with the flow with close stops, or stay away.

Jun 08 01:20 PM

[User 357705:]

Its ALL Obama's fault! All of it! Every last cent is ALL Obama's fault!

OK Rush, we heard you the first time!


On Jun 08 12:54 PM dsrtwriter wrote:

> Unfortunately Barack Obama's heros fall more along the line of Fidel
> and Hugo Chavez than our Founding Fathers, whom he regards as exploitative
> slaveholders.
>
> So we will continue to see massive spending through debt as he ramps
> up the typical socialist smorgasbord of benefits, while continuing
> to fuel his internet based grass roots pressure groups to intimidate
> even moderate Democrats to fall in line with his agenda.
>
> Like so many of the Sixties drugs, the "high" of eco friendly projects
> and laws all done in a totally contradictory world of free trade
> with China and other nations who will continue to use coal, pollute,
> etc., will finally end, with a crash.
>
> I frankly don't think that Obama has learned the lessons of Eastern
> Europe.I'm sure the Czech President and others would be happy to
> advise him on this folly, but Barack only listens to himself and
> his spouse. This will not end well.

Jun 08 01:57 PM

[bbowen7:]

Two phases - emergency room, to stabilize the patient from the crash at the end of the Bush years; nursing home, brought on by expansive government spending programs, and anti-business policies. The current market is reacting to the first, but has not yet acknowledged the second.

Jun 08 02:25 PM

[crazydave:]

bama has lots of choices... he isn't locked into anything but a collective groupthink of Keynsian economists. One choice would be to establish confidence in the dollar by way of fiscal responsibility. Cut federal programs, achieve some degree of balance, put in place needed and b alanced reforms and oversight, and public confidence will increase and spending will follow. Quit throwing around "trillions" and 100's of billions of $$. Accept a few years of adjustment, let the market weed out the weak links, and then let it grow itself. Then work in social programs which are fiscally responsible, explained and debated, and have massive public backing. All will be well, but patience and the willingness to trust the markets to self correct, with needed reforms, is all that is needed.

Jun 08 02:56 PM

[msgtb:]

Nice article but I must disagree with you on one point. The patient doesn't have a gunshot wound it has the plague. If the government doesn't let the patient die the doctor and our entire country will be wiped out. The banks are not to big to fail only the US government and the taxpayers are too big to fail. The preposterous idea that these banks are to big to fail was created by the bankers themselves. Our government is run by the big banks in New York that is clear by their actions. The Federal Reserve spending taxpayer money with out the taxpayers representatives appropriating it is clearly taxation without representation. It is also clearly against the laws and the constitution of the United States. If the worst banks were allowed to fail and the government had nationalized the better ones and written down the toxic assets, and hopes not invented Mark-to-Fantasy accounting rules, we would now be improving our economic conditions rather than getting ready for the next big wave down. The only thing the Government has done is kick the can down the road in the hopes a miracle will occur.

History will show that the course of action taken by the US Government was one of the major contributors to second depression of the 20th century.

Love your articles

Good luck and good trading

Dave

Jun 08 03:28 PM

[elliot_mllr:]

Short term rally only. Longer term is down for the USD.


On Jun 07 09:24 AM ttt wrote:

> Why is the dollar ralling last Friday, while the 10 yr treasuries
> yields raises so much ?

Jun 08 05:30 PM

[earljr:]

Stock may very well stay up in dollar figures. As Rogers said, S&P 50,000 may be on its way. Obama will print enough money to pay off everything. And everything will be worth a lot more worthless dollars.

Jun 08 06:15 PM

[Mad Hedge F...:]

Crude is the new greenback. Get me out of oil! I love a core long position in this commodity (see www.madhedgefundtrader...), and expect it to hit $200 before I join the AARP. But we have really gone too far, too fast, and are seriously in overshoot territory. Industry traders have been taking advantage of the greatest contango of all time, buying the front month contract, taking delivery, keeping it in storage, and reselling it forward to reap returns of up to 50%. And that is without leverage! Clever analysts are resorting to Google Earth to spy on storage facilities via satellite. Non industry players have been buying it as a dollar replacement. Crude burns better than dollar bills. As a result, crude in storage has ballooned to record levels. All fine and good when the price is going up. But crude can’t stay this high once the sugar high that is sustaining the economy burns off. Better to bail now at $70 and buy it back at $50 once reality sets in. And for Heaven sakes, don’t try to get to clever by shorting the stuff!

Jun 09 12:39 AM

[SageNot:]

This article proves that "timing" is everything! Guys like Gartman & Mound write daily articles, hence they're sensitive to TA reverses more so than the fundamentalists featured on Seeking Alpha.

I'm with Gartman & Mound, crude oil & gold have had it for the time being & so has this bear market stock rally.

JMHO!

Jun 09 06:20 AM

[Eagle-Chief:]

"Doctor Obama to ICU, STAT."

So, 3 doctors (Obama, Geithner, Bernanke) immediately run to the ICU. After working for a while, the patient dies. It is later discovered that the 3 "doctors" were not doctors at all, but cleaning boys dressed up as doctors.

Jun 09 03:58 PM

[finmah@yaho...:]

Debt, bankers, govern debt? Which one?

There are a couple ways to increase liquidity - issue debt or attract private capital through equity. Why do we have a tax structure that at every level promotes high amounts of leverage as opposed to equity participation? Even if house purchases require 20% that is far too much leverage along tax deductable as well. Corporations get a tax break from debt - where equity holders get double taxed.

Who voted against the tax relief for dividends. Can the mainstream media close the loop on this? What happened to making equity at the very least on par with the debt - (tax deduction for dividends). Equity is volatile but less troublesome than debt from a structural point of view as we are going to find out with a debt we cannot get rid of. And the argument that equity holders are in bigger trouble than debt right now is specious since it was general debt level that brought us here.

Maybe people should ask themselves do people who discourage workers from investing in their own company (401's are really decorative from meaningful investment) or their own country's means of production nervous that they will be held accountable for general domestic economic performance?
It is vote that needs to be explained I am sure the banking industry has something to do with it but maybe the other votes need to explain this philosophy of taxing the worker from participating in a companies rise in value.

Jun 18 11:08 AM